Life Insurance: It’s Not Just for Breakfast Anymore

I wouldn’t call Life Insurance an “underrated” financial tool, but I would call it misundastood (to quote P!nk). When I first got into the biz of financial planning, I’d heard heaps of rules about life insurance: how much you should buy, what type you should have, and most importantly: Who To Avoid When Buying Life Insurance.

Specifically, I heard this: avoid life insurance salesmen.

To many people, the above phrase translates to: avoid anyone with a clue about how insurance works because you don’t know who to trust.

Imagine my surprise when I began studying life insurance during my quest to become a licensed advisor. There were tons of policy types AND uses for term, universal and whole life insurance policies. I was amazed at how versatile a weapon both term and whole life insurance could be: among a gazillion other things, you could use it to cover income streams, save for your kid’s college or protect an estate.

3 Cases of Mistaken Identity With Life Insurance

Here are some of my favorite misconceptions.

1) The only good policy type is term life insurance. If term is the only good one, why do universal and whole life insurance even exist? Are there that many rip off artists out there to support these huge insurance companies? I doubt it. Here’s another theory:

While I’ll wholeheartedly agree that the other types (whole life and universal) are grossly oversold by people who aren’t paying attention to their client’s best interest, these products were each created for some good reasons.

Whole life insurance, for example…how great is this: you pay your premium and you know it’ll be there FOREVER. No worrying about whether you’ll still need it when your term runs out.

…and how about universal life? It lasts forever, but you can change the death benefit to match your lifestyle. Check this out:

Uncle Joe’s Universal Life Story

Sally, our horse racing fan from the last story, has three boys: Larry, Curly and Morris (she nicknames him, surprisingly, “Moe” for short). As each boy leaves the house at 18 to become a real-life superhero, Sally now needs less insurance and lays off the vodka a little more. She calls her insurance company and sinks the death benefit down to reflect her new need. Now she can pay less money each week OR have more of her premium go into the cash value (money inside the policy) so that she can stop paying for the policy early and enjoy more retirement dollars without a life insurance payment. That’ll give her more money for the ponies. Win!

Cool, huh? I can hear the detractors beating on my door, pitchforks in hand. “You’re going to pay through the nose for those universal and whole life insurance benefits.” Duh. Let’s see a show of hands of people who think insurance companies give stuff away for free. Anyone? Here’s a little secret: any time insurance companies agree to sell you a guarantee you’re gonna pay for it.

2) You only need Life Insurance to cover income needs. Whole, Universal, and Term Life insurances are valuable tools for a variety of reasons:

Burial costs: If your money is in places that are locked up you might not be able to cover some of the costs quickly. Life insurance money can often be ready within a matter of a few days.

Liquidity: Some of those locked up places, like rental homes, aren’t liquid immediately. Life insurance can buy flexibility.

Business concerns: How many spouses of business owners are qualified to run the biz after the owner dies? In most cases, they aren’t. With the proper legal documents and a life insurance policy, the spouse is bought out and a capable underling, associate or competitor takes over the business. (term life insurance isn’t appropriate for this)

Estate needs: For large estates, there may be estate taxes due. These can be higher than 50% of the value of the estate. Ouch! Life insurance is an inexpensive way to cover these costs. (term life insurance isn’t appropriate for this)

3) Buy life insurance when you’re young and don’t need it because it’s cheap. Huh? Lets say there’s a special on Spam and it’s only $.05 per can. Are you going to buy 100 of them? No. Why not? Because you don’t need them. Apply that same principle to life insurance, whether it’s permanent or term life insurance . While there are a myriad of reasons why you might need insurance, don’t get caught in the “it’s cheap” trap.

Tasty stuff, Joe (pun intended). I’m a die-hard term guy, but have a bunch of friends who have Universal or Whole policies because they just can’t stand the concept of losing the life insurance after 10, 20 or 30 years. It’s certainly expensive to carry the costs of it, but a bunch of people feel that death benefit security is worth the extra costs.

What I do is auto-invest the difference (actually only 2/3 of the difference because the math worked out this way) between term and whole life premium into a mutual fund account nicknamed “Life Insurance Cash Value.” (Yes, it’s literally called that at my bank.). I ran the math on the mutual fund based on historical performance, discounting it by 2% per year in case the next 30 years aren’t as good as the last 15. Then I compared the projected “amount my family would get if I died” for every 5 years until 65 years old and at no time would my family (or me while alive due to the “Cash Value” account) be better off in Whole.

BUT – It took quite a bit of math and some discipline to set it all up so I can have the “whole life FEEL” with only a term life policy…. Some people just buy whole life.

I wonder how life insurance would help deal with my online business if I kicked the can early. Since I don’t have any dependents, the businesses would just die off and I don’t know if anyone would even get the passive income that came in for years after. When I have kids though, I’d want that to be looked after somehow. I haven’t fallen for the trap of getting life insurance young just because it’s cheap. If spam really was only 5 cents I might reconsider that option though.

I was going to say what great advice this is, and how much I enjoyed listening to the podcast interview with Jeff Rose. I even linked to the interview on my blog post about insurance. But I got completely sidetracked after you quoted P!nk and used misundastood. Haha! You’re awesome.

I’m laying down my pitchfork carefully…ok let’s talk. I like your other side of the fence discussion. I think it all goes into the purpose of life insurance. The ‘why’ will lead you to the ‘how’. I’m sure there are some cases where term isn’t the best option, but I’m guessing a smaller percentage.

I think you just offended the whole state of Hawaii with your Spam comment! ha ha! If you don’t subscribe to the buy it when you’re young and cheap, what about buy when you’re young and healthy? Good health isn’t a given as we all age.

The “Moe” parenthetical nearly made me spit out my coffee! Let’s say you are unmarried, without children or pets, and the daughter of two upper-middle class people. What say you, then? Do I need life insurance or can I wait until I have a family?

Interesting and informative; great! I was most struck by the last point – don’t fall into the trap of ‘it is cheap’. However, taking out life insurance when young should be done if one has dependents and no insurance to go with their pension scheme. As to age – I managed to get much cheaper rate when I was older (the market has become more competitive).

Some great tips, Joe! Few things make me wonder about whole life. First, if you die then the insurance company will pay your family for the amount you were insured for. But, the cash value won’t be paid to the family. Second, the premium difference is normally huge between whole and term due to the commission payout in the initial years.

I’d love to hear your thoughts about those concerns. Thanks in advance.

Great question, Shilpan! So good, in fact, I think I might bring this up on the podcast. The real reason for the cash value is self insurance. Because the cost of insuring someone gets higher and higher as the insured ages, you put extra money in so that the difference between what you get (death benefit) and your own cash is narrow enough that it’s affordable.

That’s actually the answer to your second question: the premium difference is huge because there is 100% chance there will be a payout with whole life policies. With term (I don’t have the number in front of me) it’s somewhere in the 5-7% range. Term is priced lower because 93% of the policies are profit. With whole life, they have to find the profit.

…which brings up the GIGANTIC commissions on whole life policies. These are paid through the abysmal returns offered on the cash value. The insurance company is investing that money for much, much more than you’re receiving in a whole life policy. That’s why this type of insurance is best used by people who are very, very, very risk adverse. They’re willing to pay through the nose for coverage. I’ve met these people, and I can’t tell them they’re wrong. If you won’t sleep at night, you should buy the security. For most of us? Term wins the day.

Joe, you are raising a good point as usual. I think sometimes these can be so complex that most people don’t bother to figure out whether they are getting a good deal, and it ends up robbing them of much wealth. That’s probably why people try to simplify insurance. For the most part, the simplification is meaningful and saves a lot of people significant sums of money, provided that understand some basics.

You do make a good point Joe. There are different options for different situations. We however have chosen term. Our plan is to build up enough assets to not need insurance anymore. Regardless of what kind of agreement people sign up for, they still need to realize the importance of saving and not being in debt. Life insurance and dying is not the answer.

This is fantastic Joe! As a former advisor myself I know how wary people can be, but as you say when it comes to life insurance you need advice from someone who knows what you really need and is able to match that with the best insurance product available!

Life insurance is must have for everyone who have dependents under them. As you sed term life insurance is real insurance product and you should have only term insurance cover. For investment you can search fro different areas like mutual fund, stocks etc.

Your comments are right on! It is hard to trust people who are “selling” you on something that you know nothing about. There are so many sites (like yours) that are educating people on insurance. And this is the way that people can start to open themselves up to trusting people. Find an adviser that knows what you want and where you are wanting to go.